Azerbaijan-Russia Gas Agreement: Implications for Nabucco Project

Azerbaijan’s State Oil Company President Rovnag Abdullayev

On October 14 in Baku, Azerbaijan’s State Oil Company president Rovnag Abdullayev and Gazprom CEO Aleksei Miller signed an agreement on Azerbaijani gas exports to Russia. The move is a logical follow-up to the June 29 agreement, signed by the same company chiefs –in the presence of Presidents Ilham Alyiev and Dmitry Medvedev in Baku on that occasion– on the main principles of the gas trade between the two countries (EDM, July 2, 17).

This agreement turns Azerbaijan for the first time in history from an importer of Russian gas into an exporter of gas to Russia –albeit with small initial volumes– thanks to growing internal production in Azerbaijan. If understood and handled appropriately by the European Union and Turkey, this event can lend impetus to the E.U. and U.S. backed Nabucco pipeline project, notwithstanding European media speculation that Russia is pre-empting Nabucco’s Azerbaijani gas supplies.

The documents just signed involve a framework agreement for the years 2010 to 2014 and a sale-and-purchase contract for 2010. During this first year Azerbaijan shall export at least 500 million cubic meters (bcm) of gas to Russia through the Baku-Novo Filya pipeline, for use in Russia’s North Caucasus territories. Azerbaijan may increase that export volume during 2010, at its discretion. The gas may originate in any of Azerbaijan’s fields (Trend Capital, www.day.az, October 14).

The Russian purchase price is not publicly specified. According to Abdullayev at the signing ceremony, the price-setting formula “suits the Azerbaijani side” – apparently a hint that the price is in line with the anticipated European netback prices for 2010. This had been Baku’s objective all along in the negotiations. Miller had proposed to buy Azerbaijani gas at $350 per one thousand cubic meters in the lead-up to the June 29 preliminary agreement.

Azerbaijan used to import Russian gas until as recently as 2006 through the old Baku-Novo Filya pipeline, which runs for approximately 200 kilometers along the Caspian Sea coast from the Russian border to Baku. This line will now be used in the reverse mode to carry Azerbaijani gas to Russia. The volume envisaged for 2010 will use only a fraction of this pipeline’s Soviet-era capacity. In addition, Azerbaijan is preparing its own section of the old Mozdok (Russia)-Gazimahomed pipeline, for possible reverse-use as a gas export outlet to Russia (Trend Capital, October 1).

Gas extraction in Azerbaijan is set to reach 27 bcm for 2009 (www.day.az, October 8). The rate of increase could have been faster, but has been affected by slowed development at the giant Shah-Deniz offshore field. That slowdown in turn reflects delays on the Nabucco pipeline project and Turkish government obstructions to a gas agreement with Azerbaijan. These two factors have postponed the opening of Azerbaijan’s gas export route to the West. In this situation, Azerbaijan can only open an export route to Russia while awaiting progress on Nabucco and with Turkey.

Meanwhile, Azerbaijan remains committed to the Nabucco project. The government and the State Oil Company are consistently reaffirming Baku’s readiness to supply 7 bcm per year for that pipeline’s first phase. Construction work on Nabucco is now expected to start in 2011, for the first gas to flow by 2015 from Azerbaijan to Europe.

Consequently, Baku has set the time-frame of the agreement just signed with Gazprom to expire in 2014, so as to release Azerbaijan from obligations to Gazprom after that year. Miller, however, declared at the October 14 signing ceremony explicitly that Russia wants to prolong this agreement after 2015, and for larger volumes of Azerbaijani gas. That would pose risks for Nabucco. The October 14 agreement does not.

This agreement, however, reiterates and amplifies certain lessons for the E.U., Turkey, and U.S. that were in the June 29 preliminary agreement. Azerbaijan’s move can actually help concentrate minds all-around on the Nabucco project, bearing the following considerations in mind.

First, the volumes committed to Gazprom are meager and the time-frame does not impinge on the Nabucco project, assuming that Azerbaijan retains the necessary Western support to pursue Azerbaijan’s own Western choice. Awaiting Nabucco’s commissioning, it makes sense for Azerbaijan to use the existing pipeline(s) to Russia for exporting Azerbaijan’s growing surplus of gas during the interim period until 2014.

Second, this agreement does not allow Gazprom to compete against Nabucco for Azerbaijani gas. But the situation could change in Russia’s favor, if Turkey’s AKP government insists on its extortionate terms for the purchase of Azerbaijani gas and its transportation through Nabucco. By the same token, Washington and the reshuffled European Commission, now entering a new term of office in Brussels, are being reminded that they need to lift that logjam in Ankara.

Third, Baku’s agreement with Gazprom is a reminder to Ankara that Azerbaijan does not totally depend on the Turkish gas market or the Turkish gas transmission route. From Azerbaijan’s standpoint, adding a Russian export outlet –albeit a small one– is an export diversification move, away from Turkey’s perceived monopoly on transportation, which the AKP government seeks to abuse. Azerbaijan can also use the Baku-Astara pipeline to Iran, or swap arrangements with that neighbor country, during the interim period until 2014.

Fourth, Baku is successfully ruling out Gazprom’s wish to re-export Caspian gas to European countries, at a profit to Russia and at the expense of Caspian producers. Baku has stipulated that its gas shall be used in Russia’s North Caucasus. And if the Russian purchase price is consistent with European netback prices (as envisaged at the time of the June 29 preliminary agreement), Baku will have achieved a strategic gain. Turkey’s AKP government would place itself in an embarrassing position by insisting on worse terms than Russia has now consented to Azerbaijan. Across the Caspian Sea, Azerbaijan will have set a useful precedent for Turkmenistan to also demand European netback prices from Gazprom. If Russia declines to meet that benchmark, then a part of Turkmen volumes would become available for the proposed trans-Caspian link to the Nabucco project.